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August 2018

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« What can boiling water teach us about management? | Main | Changing View of Competition »

Compensation Drives Behavior

Compensation drives behavior… fairly straightforward and not really that complicated.  But many still make foolish decisions when thinking about it… with their employees and even their service providers.


Let’s start with service providers - since I’m one and I get to write this thing ;-)  Often when discussing a re-organization with an owner, they think they’ll get me to “put-up or shut-up” by suggesting my billing should not be based on my normal weekly rate, but rather on some percent of actual increased profits that my assistance drives to the bottom-line.  I always smiling knowingly and tell them that I will GLADLY accept this compensation structure… it gives me the opportunity to put A LOT more money in my pocket and I know the financial results of “pre-Conlin” and “post-Conlin” in every re-org I’ve ever done… I’ll gladly step to the plate on this…


I then proceed to explain to the owner why they don’t want to pay me in this manner and why it would be to their detriment to do so.  A compensation system won’t actually manage anyone, but it should align people in the same direction… get them to at least a broad outline of win-win for various actions.  But if you pay me based on putting more money to the bottom-line, that’s exactly what I will do… whether it is in your best interest or not.  It gives me a strong financial incentive to think only short-term and to cut as deep as is possible.  Now I might not do so, but the compensation design points me in that direction. 


Each of you have probably heard of these horror stories about a re-organization… huge cuts are made and great promises given… unfortunately, the service provider hacked away, quickly met the goal and took the money and ran… and then the wheels fall off in 6 to 9 months causing great organizational turmoil AND all those wonderful savings prove to be illusionary… everyone then gets religion and realizes that “going cheap is expensive”… often costs increase to deal with the turmoil of the failed change.  The cost cutting task was completed but as I remind people, any fool can cut costs… you simply walk around and point at various people telling them they no longer work here!  To properly do this, you have to build a new and more efficient system from the ground up.


But that’s what happens when you don’t design an organization well and you cut too deep… for a while it will work as employees suck it up and some “non-critical” tasks simply don’t get done.  But sooner or later it all catches up and comes tumbling down… generally all at once.  But of course the service provider has the all purpose “get out of jail free card”… it was working when I left… meaning of course that any failures couldn’t be their fault, it must by yours.


You don’t want to pay me (or anyone) in this manner since it gives an incentive, in fact it directs behavior to do things which might be in my best interest, but not in yours.  Instead you want to design my compensation system so that our interests are completely in line… a win-win. My goal is to provide value-added service which pays for itself many times over and maximizes the benefits to my clients.


The same silliness happens in joint ventures and mergers… some service providers suggest billing on a “success” fee… the question is, who’s success?  Under this scenario they don’t get paid unless the joint venture or merger actually happens.  Think about it… what incentive does this give them?  Clearly it is to get the deal done… period.  They most certainly aren’t looking out for any party’s interests other than their own.  This can lead to bad outcomes for everyone other than the service provider.


A similar situation exists in residential real estate… here in Colorado they had to add a law so that if you use a broker in the search for a home, the broker has to explicitly explain to you that they DO NOT represent your interests… they are simply showing you homes but you’re on your own in protecting yourself.  The law was implemented because there were too many screwed home buyers who rightly thought the person they hired, “their” broker was actually looking out for their interests.  Seems like a reasonable belief when you hire someone, but that’s not always the way it is.  You don’t want to make the same mistake in analyzing and building a joint venture… better to have someone who is looking after everyone’s interests rather than just their own.  Think about the incentive the compensation structure is providing.


A joint venture or merger is without a doubt one of the most profound business decisions you can make… a wise attorney once told me to pick my partners with more care than I would in picking a wife… I’ll spend a lot more time with my partners than my wife and ultimately they will most likely have a much more significant impact on my business and personal success.  Wise counsel.  You can’t start a successful JV without completely open and honest discussions… not a blind desire to get a deal done so that I can pocket a boat-load of cash!


I had one attempted 3-way merger where after my initial one-on-one interviews with each party it was clear that their individual desires were in too much conflict for the thing to have any chance of working.  I told the group my reasoning and we ended it there.  Would the incentive have been the same were I hoping for a “success” fee?  All three parties subsequently took different paths, all to their individual gain.


In another situation I had a reluctant merger partner who just couldn’t (wouldn’t?) accept the reality on the ground.  Although I told him I thought it was a serious mistake to do so, my advice to him was unless or until he could more fully embrace the merger in total, he should walk away.  Otherwise I was quite certain he would not be happy with the results of the merger.  That was my heartfelt advice to him… it was not in my best interests but it was the truth as I saw it.  Would the incentive have been the same were I hoping for a “success” fee?


Some of this “success” fee confusion comes from mixing things which are fundamentally different.  A success fee in a brokerage transaction – selling or acquisition – makes perfect sense.  If I can help sell your business for $40M versus $30M, that’s a good thing and an incentive to do so makes perfect sense.  But a joint venture’s value is what it is… my efforts won’t change this.  Sure my re-organizational wizardry will help you design an organization which maximizes both sales and profits, but this has noting to do with the concept of a merger or joint venture.  In a joint venture one is simply analyzing if the various parties can actually come to some agreement and if so, helping to structure ownership, the operational organization and the corporate design of this new entity.  A success fee in this makes no sense… unless you want “your” service provider to only care about getting a deal done at any cost…and remember, the cost is solely yours.


Remember, compensation drives behavior.  If your sales force is a generalized one, i.e. a single sales rep calls on off-premise and on-premise, do you pay a different (and higher) commission rate for on-premise volume?  You should.  Otherwise what is your compensation system telling your employees?  Whether you know it or not it is telling them to place much less emphasis on the on-premise business.  Think of it from a sales rep’s perspective… if I have an extra 15 minutes in my day, what should I do with it?  I can go to a local on-premise establishment and perhaps make a placement and sell a few cases.  Or I can go to my local chain grocery and perhaps sell a hundred.  Even if I just pull-up the store I can probably make more money than by stopping at the on-premise account.  But we all know this is short-term thinking… those on-premise cases build brands which sooner or later flows over to larger off-premise sales.  To hope your sales reps take this long-term view is generally wishful thinking… this isn’t a knock on them, it’s just human nature AND the incentive your compensation system is giving them… let me repeat, your compensation system is quite directly telling them to do this.  Therefore adjust your compensation system so the on-premise business remains an important part of a sales rep’s mindset. 


To effectively address these significant differences both in product mix and account types for many sales reps, some wholesalers have eliminated the variable commission component of the company’s sales compensation plan in lieu of providing more performance based incentives.  A revised base plus incentive structure could ensure proper alignment of activities. Individual incentives would then be tailored to integrate unique individual goals for each sales person as part of overall company goals for sales and distribution. Again a WIN/WIN when properly designed and thought out.


Some distributors have retained a driver-sell mentality in their compensation systems.  In a driver-sell world, generally cases and effort went hand in hand… with compensation following.  But in a pre-sell world this is not the situation.  With bulk/dock deliveries, often the driver who delivers the most cases actually has the easiest work-load… yet if you retain a driver-sell mentality, these routes will make the most money.  Let’s see… easiest work load and the most money… compensation drives behavior… and what behavior does this drive?  Everyone and his dog wanting to get on these easiest routes… and whining about working harder… demoralizing… damaging team building… a lose-lose across the board.  In a physical job like a delivery driver, compensation should match both the skill required and the physical effort the job requires… it could be that the lowest volume route is the highest paid.  There is more to it than simply volume.


Whether in sales or delivery or even management, compensation should match the skill-level and effort the job requires… adjusted of course for the availability of these talents in your local marketplace.  Taking orders is not the same as selling… why pay them the same?… especially when compensation drives behavior.  Make certain it drives them, whether they are employees or service providers, in the right direction.



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